Rio Tinto plc: A Stock Built On Chinese Whispers

I admire Rio Tinto (LSE: RIO) (NYSE: RIO.US) as a well-managed global mining giant whose chief executive Sam Walsh has a clear-sighted strategy. But I’m also wary, because I suspect believe the market cycle is moving against it. In this case, the so-called “commodity supercycle”.

This cycle shifted downwards when Chinese GDP growth slipped below double digits. The authorities are targeting 7.5% this year, so it’s not exactly a disaster zone, but the glory days are over, probably for good. Plus there is always the danger of something nastier, given the country’s towering credit and property…

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From A Whisper…

I admire Rio Tinto(LSE: RIO) (NYSE: RIO.US) as a well-managed global mining giant whose chief executive Sam Walsh has a clear-sighted strategy. But I’m also wary, because I suspect believe the market cycle is moving against it. In this case, the so-called “commodity supercycle”.

This cycle shifted downwards when Chinese GDP growth slipped below double digits. The authorities are targeting 7.5% this year, so it’s not exactly a disaster zone, but the glory days are over, probably for good. Plus there is always the danger of something nastier, given the country’s towering credit and property bubbles.

To A Scream…

What Barclays has just described as “waning resource-hunger from the Chinese economy” suggests things could remain rocky for Rio. China is its key buyer, snaffling up roughly half of the company’s iron ore production. So when Beijing drops quiet hints of more stimulus to come, Rio’s share price shouts the news to the world. This is a stock built on Chinese whispers.

It is also built on Wall Street whispers. Rio started this week on a roll, after JP Morgan Chase & Co upgraded its rating for the European mining sector from ‘underweight’ to ‘overweight’, on the back of falling costs and improving demand from China. Rio Tinto was its top pick, alongside fellow miner BHP Billiton.

But you can’t build an investment case on whispers and rumours alone. And you certainly can’t time your investment according to macro risks such as such as a China meltdown. You will never call that correctly, nor can you predict the policy response. Like central bankers the world over, the Chinese government won’t allow bubbles to burst, but patches them up a fresh wodge of stimulus. What you can do, however, is look at the numbers.

Rocking With Rio

Rio’s recent Q1 results were rocking, with iron ore production and shipments at all-time highs. It also produced 156,500 tonnes of copper, up 17% on one year ago, and big numbers on bauxite. And it continues to meet Walsh’s goal of cutting exploration and evaluation spending, down from $256 million to $156 million year-on-year.

Rio’s share price is down almost 20% over the past three years, which could make now a contrarian buying opportunity for those who want to get in before the cycle swings upwards. The chance to buy a company this good at just 10.2 times earnings looks too good to miss. Plus you get a forecast yield of 3.9% by December. Forecast earnings per share growth of 14% in 2015 shows promise for the future.

In the shorter term, Chinese whispers can make or break Rio’s share price performance. But in the longer run, the stock looks a screaming buy.